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Further Reputational Damage to CEZ As EC Launches Third Inquiry Into Czech Electricity Market

Published: 9/23/2010 Subscribe|ArchivesFollowing the publication of a letter alleging collusion within the Czech electricity market, the European Commission has launched another inquiry into the activities of state energy champion CEZ.

IHS Global Insight Perspective

Significance

Following the publication of an article in the Financial Times alleging collusion in the Czech electricity market, the European Commission (EC) is opening another investigation into CEZ and the wider energy market.

Implications

CEZ is already struggling to contain damage to its reputation from a series of previous issues such as brutal methods employed in reducing electricity theft, undue influence over Czech politics, and profiteering from free carbon credits.

Outlook

This latest probe comes on top of two existing EC investigations into the Czech energy market; the most likely outcome is that the government will seek to mollify the EC by reducing its stake in CEZ, while the EC may also force a more effective separation of CEZ and transmission system operator CEPS.

Tender Process Usurped by Private Agreement

The European Commission (EC) confirmed on Monday (20 September) that it is conducting a probe into alleged collusion between CEZ, EnBW, and J&T Group, in the Czech electricity market. The inquiry comes as a result of an article published in the Financial Times last Friday (17 September) detailing an agreement between the three parties to consolidate their market power through a series of share swaps. The article cites a letter, dated 24 June 2009 and containing the signatures of senior officials at all three companies, concerning the tender of the Czech assets of U.K.-based International Power. These assets comprised the Opatovice power plant and a 49% stake in Prazska Teplarenska, a district heating business. The letter sets out an agenda whereby EnBW would gain majority control of Prazska Energetika (the main electricity supplier in Prague) in exchange for not bidding on International Power's Czech assets and swapping its 41% stake in Prazska Teplarenska with J&T Finance Group. J&T Group subsequently purchased International Power's assets directly, bypassing the formal tender process (see "Related Articles"). On 1 July 2009 CEZ purchased the 49% stake in Prazska Teplarenska that J&T had acquired from International Power. Hence EnBW secured a majority stake in a key downstream market while CEZ and J&T Finance Group ended up with nearly 100% control of a lucrative district heating network. At the time, International Power's abrogation of the tender process prompted Czech Coal to protest the sale, arguing the case represented an unfair market distortion. Czech Coal has long argued that CEZ abuses its dominant market position (comprising nearly 65% of installed capacity) and uses J&T Group as an off-balance-sheet special purpose vehicle, to avoid the gaze of the Competition Commission.

The Tail Wagging the Dog?

Although J&T Finance Group and CEZ have denied any wrongdoing, the agreement clearly implies a further increase in the latter's market share at the expense of a transparent, competitive tendering process—enough to warrant an inquiry at least in the eyes of the EC. This comes at a time when CEZ's public relations are already at a low point. The utility is already under investigation for market manipulation and if found guilty of manipulating the market, CEZ could face a maximum fine of 10% of revenues, which could be 18.2 billion koruna (US$0.9 billion). The utility came in for sharp criticism from the police in February this year over its extreme methods used when dealing with illegal electricity tapping. Equally, the fact that CEZ ranks seventh among European companies that profit most from excess carbon credits while increasing its nominal coal-fired generation output did little to appease environmentalists. Additionally, Czech power prices are high by European standards and are set to rise a further 15–20% next year. This is unpopular amongst businesses and households alike, especially in a recession. The high prices are partly a function of generous feed in tariffs (which are set to be scaled down after a boom in solar photovoltaic (PV) power through 2009, following trends in Germany and Spain) but also of high market concentration. Perhaps most damagingly, CEZ is perceived by many in its home market as exerting unjustifiable influence over politics. Media reports suggest the utility is backed by a "cartel" of big political parties—a perception reinforced in 2009 by the publication of images showing politicians from both the right and left holidaying with CEZ lobbyists in Italy. Indeed, some have even gone so far as to suggest that more power resides in the boardroom of CEZ than in the government itself. In March, former environment minister Jan Dusik resigned in protest over "undue pressure" from the utility to agree to plans for the reconstruction of Prunerov II, a massive coal-fired power plant and Europe's 18th largest emitter of carbon dioxide. Despite the minister's resignation and an independent environmental impact assessment by Det Norske Veritas (a Norwegian classification group) arguing against the reconstruction, the Environment Ministry agreed to the plans in early April. Following elections in June this year, the new government has made clear it plans to take a more active role in the country's energy sector. This could be interpreted as an attempt to rein CEZ in and impose greater transparency, or simply as recognition of the industry's strategic and economic importance.

Outlook and Implications

The most likely outcome of the EC's investigation (which is still in its early stages) is that the government and CEZ will take pre-emptive action to mollify the EC before any fine is levied. This may well take the form of a 7% reduction in the state's share, since such a divestment has been mooted in the past as a means to help reduce the country's deficit. However, that may not be enough. In September 2009 ownership of the transmission system operator (TSO) CEPS passed from the Ministry of Finance to the Ministry of Industry and Trade. This transfer took place in order to ensure compliance with the recently passed Third Energy Package provisions on unbundling: the main shareholder in CEZ is the Ministry of Finance; hence the same arm of government could not retain control of the TSO and a utility with 65% of the country's generation capacity. While technically within the rules, the new arrangement could be seen as allowing continued diffusion of knowledge between CEPS and CEZ. Consequently, the EC may insist on greater regulatory oversight (in addition to the National Regulatory Authority provisions contained in the Third Package) to ensure separation of transmission and generation activities. This may take the form of reducing state ownership of CEPS (currently 100%) or more stringent provisions to ensure sufficient "Chinese walls" between the two firms. These might include requiring a longer cooling-off period when executives move from one company to another, or restrictions on communications.

Given that this inquiry is simply an additional probe in an ongoing investigation into the Czech energy market as a whole, CEZ may not be too concerned by these announcements. Still, the EC showed last year through its treatment of E.ON and GDF Suez that it is willing to impose massive fines for collusion in energy markets. That these fines were imposed during a recession on powerful national energy champions for actions taken in 1977 surely demonstrates that the EC will not shy away from upsetting politicians.

Related Articles

Czech Republic: 1 July 2009: International Power Concludes Deal for Sale of Czech Unit